Crowdlending vs. crowdfunding… what’s the difference and why does it matter?

blackboard with the word 'debt' written on it

Crowdfunding has become a hot topic recently and the news that Kickstarter has will officially launch its UK operation at the end of this month means that it will probably stay in the headlines.

Whilst the concept is still relatively new in the UK, Crowdcube (the UK’s biggest crowdfunding website) has helped to raise £4 million for small businesses and Seedrs – the first UK crowdfunder to be regulated by the FSA – has a target to help 400 business raise cash from private investors each year.

There is a genuine surge of interest in alternative finance and for many the idea of ‘owning’ a part of a start-up seems really appealing.  Frequently the chance to support an appealing new business idea is a stronger motivator than the potential financial return.  There is a “community funding” aspect to crowdfunding, as it tends to select the businesses that are perceived to benefit people.

So, that’s crowdfunding; Basically the process by which a business, which is often – but not always – a start-up raises funding in return for some type of equity deal or reward.

But what about crowdlending?

Well, we started using the term crowdlending to describe FundingKnight just after writing this blog post on whether peer to business lending needs a new name? (Which in turn took inspiration from the Lend Academy blog in the US)

The key point about crowdlending is that no equity changes hands.  FundingKnight lenders, or those using other P2P websites to lend to individuals or businesses, simply provide “loans”.

In return, they get a rate of return on their savings which very often beats that available from traditional easy access savings accounts (which right now are struggling to beat inflation!)  They take no share of the company, have no say in how the company is run and have no voting rights or other control over day to day operations.

So, why might an independent business that’s searching for business finance prefer to take a loan – otherwise known as “debt funding” rather than sharing out equity in their company.

Knowing that it’s a topic close to the heart of FundingKnight’s founder and CEO, Graeme Marshall, I asked him to share some of his thought on why debt can sometimes trump equity when it comes to funding a business.

Here’s what he said:

“I often see company’s approaching Angels for equity when they really should be looking for debt.  It was one of the reasons I started FundingKnight.  Why would someone running his own business want to burden himself with outside shareholders whose agenda will almost always be different from that of the owners?”

So that’s the first key difference between crowdlending and crowdfunding:

Crowdlending = Lenders make loans and borrowers pay them back.  No shares change hands, no control of the business is given up.

 

Crowdfunding = Investors provide a cash injection in return for equity in the business or some other reward.  Usually, they will then have a say in the future of the business / how it is run.

Next, comes the question of what happens when investors – or lenders – want their money back?  It’s a reasonable question since, after all, circumstances change for all of us.  Today’s rainy day fund is tomorrow urgent repair fund so having a way to access an investment is pretty fundamental.

When it comes to business finance, Graeme says,

“The key question is “how is the equity going to be turned into cash?”  Ideally, Shareholders need to be aligned on this point.  If not, there needs to be a clearly understood strategy setting out how new shareholders are going to get their cash.  Listed companies whose shares are traded avoid this problem…. Private companies are a minefield!”

So, there’s the second real difference:

Crowdlending = A scheduled plan of regular payments is agreed upfront detailing how a lender will be repaid their capital + interest.

 

Crowdfunding = Every business needs its own strategy for how shareholders can realise their cash… and not all shareholders will agree on the best way to do this!

 

And that’s why Graeme believes that profitable businesses who are expanding should look to borrow first:

“If the cash required for expansion is to turn into profitable sales of goods or services, they should have the means of repaying the loan out of these profitable sales.  It’s also a good discipline on a company, as if they are not generating the cash to service a loan, is the expansion really profitable?

At the end of the day, every business who borrows money needs to know how they will pay it back.  If you can’t see this clearly, but the cash you need it clearly building long term value, you need equity.”

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One thought on “Crowdlending vs. crowdfunding… what’s the difference and why does it matter?

  1. Pingback: The Low-Down on Business Investment | FundingKnight: The Blog

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